When is it Time for Succession Planning?
Common wisdom among serial entrepreneurs is that you plan your exit at the same time you start your business. We know that most closely held business owners don’t think that way. They are owner operators who love what they do and are often involved in the daily operations of the business.
However, a business is most valuable when the owner is less essential to daily operations. When should that physical (and mental) transition take place?
To explore this big question, MFB managing partner Tom Terry spoke with Gregg Schor, the CEO of Protegrity Advisors, which focuses specifically on strategies to position businesses for maximum value mergers or acquisitions. Even if your business will eventually transition to an internal leader or family member, we learned that the key steps for transition are somewhat similar to M&A positioning. In addition, Schor presented some new insights on how the M&A market is giving owners more options for their business exit.
Tom: When is a good time for succession planning or business transition planning?
Gregg: It’s always best to prepare when you’re not under pressure or under the magnifying glass of a potential buyer of your company—and their teams of advisors. You want to do things at your own pace. Even if the transition takes place within the family, you can have an unexpected change in the health of the owner and suddenly there isn’t enough time to groom and train the next owner. It’s an important transition and you don’t want it to be rushed.
Tom: So if you plan for when you’re trying to exit, whether that’s five, 10 or 20 years down the road, it allows you to put procedures and controls in place to allow the entity to continue on.
Gregg: Right. We’ve seen a wide spectrum of inadequate contracts in place for employees and between owners. For example, long-term employees don’t have employment contracts; we’ve seen missing non-competes and non-solicitation of customers and other employees. You need your house in order from a legal and business perspective. We’ve also seen some companies where the largest customer doesn’t have a contract in place, which makes it difficult for a new owner to count on keeping that asset. Risk mitigation is a critical factor in increasing the purchase price.
Tom: I always liken this process to how often people look at their stock portfolios. Retirement is a long goal, but people look at the numbers monthly or at least quarterly. How often do owners look at what their business is worth and try to maximize the valuation for some time in the future? You need to look at business value just as regularly.
Gregg: If you have the right accounting firm, that goes a long way to expedite the process and give additional security to the buyer. You want your books and records in order because we’ll want to know the prior three years of profit and loss in order to calculate projections for the next year or two. Most of the time, a purchase price is based on some multiple of your adjusted earnings. If the books and records are in disarray, it can take a lot longer to get our arms around things. Most owners are not willing to sell unless we’re looking at a multiple of at least three to five times adjusted earnings, so it’s important to be able to count on what that number is.
Tom: But we know that a business is only as valuable as what a buyer is willing to pay. What else should owners have in place to support a successful transition?
Gregg: You want more of a management team and key employees in place compared to just the owner running things. Having a good team makes the business more valuable. If I’ve worked myself out of a job, I’m doing a good job as the owner. Also, customer concentration…is it too shallow for the industry norm or is turnover too high? Do you have contracts with your salespeople that prevent them from leaving and taking customers with them? Are key employees enticed to stay with some type of stock option or transaction bonus? The sooner you think about these things, the easier it is to determine the best incentives and strategies.
Tom: Let’s say you have your business house in order. What is the average timeline for succession and who are potential buyers right now?
Gregg: A good average range is six to 12 months for M&A from start to finish, but it also depends on different variables such as the time of year and revenue and earnings trends. The good news is there are a number of interested parties in the buyer universe. It used to be primarily strategic buyers such as competitors who had complementary products or services. Then private equity got into acquiring companies. Initially PE firms were only focused on very large companies, but now there are all different sizes of acquisitions and areas of specialization. Some PEs are focused on social impact investing, and are buying medical practices and other community-oriented companies for their portfolio. Also, family offices—think of a private company that manages the investments of a wealthy family—are now buying companies directly instead of investing their money into PE firms. And serial entrepreneurs are buying companies rather than starting them; they take them over later in the process. A relatively new dynamic is the search fund, which is given an allowance by a group of investors to look for companies to buy in certain sectors with specific criteria. The bottom line is that because there is a relatively small pool of qualified sellers compared to the number of qualified and well-funded buyers, now could be a very good time to explore your options for transition, or at least make an informed decision about whether now is the right time.
Tom: Again, those qualified sellers are the ones who treat the business like its own entity with management rather than the owner treating the company like his or her personal life. Regardless, if in five years the owner sees him or herself being out, but there is nobody internally to take over, it’s really time to start thinking about that exit plan.
Gregg: Exactly. We can sometimes research comps for similarly situated companies, but it’s more difficult with closely held transactions. Even if you get an overall number, that may not include earn-outs or escrow or employment and consulting agreements. The devil is in the details, which is why you shouldn’t wait until business is bad. If you plan ahead, you can potentially have more than one interested party and have leverage in negotiations for the best terms possible. In other words, the best time to think about your exit is when you don’t need to.